Wednesday, 11 June 2014

Large
banks and trading firms are frantically trying to determine whether they have
fallen victim to a suspected commodities fraud emanating from the giant Qingdao
Port in northeast China.

Citigroup
and several other large Western banks are concerned that their loans may lack
the appropriate collateral, big stockpiles of copper and aluminum at the port.
The banks have inspectors on the ground who are trying to assess whether enough
of the metals are there.

The
worry stems from suspicions that a Chinese company pledged the same collateral
for multiple loans. Chinese authorities are investigating the matter.

The
case could have broad repercussions for the commodities market and the Chinese
economy. Banks have funneled billions of dollars into the Chinese economy
through these murky transactions, and commodities prices have been falling over
concerns that such lending will dry up.

Western
banks, including Citigroup, are bracing for any potential fallout.

Just
months ago, Citigroup fell victim to a multimillion-dollar fraud in Mexico. If
the Qingdao developments harm the bank, regulators and shareholders are likely
to press it to explain why its controls had failed again.

Citic
Resources, part of the state-controlled conglomerate Citic Group, plunged
nearly 10 percent on Tuesday after it disclosed that it might be affected by an
investigation into stockpiles of metals held at the port. Citic Resources said
on Monday that it had asked the local Chinese courts to secure its metals
stockpiles. The shares recovered on Wednesday.

The potential fraud is linked to an
opaque corner of China’s financial system that has grown substantially in
recent years, bringing huge amounts of capital into the country. Many Chinese
companies and investors, struggling to secure traditional loans from the
state-dominated banking sector, have instead turned to alternative, unregulated
financing methods involving imports of materials like copper, aluminum and iron
ore.

These
commodities financing deals are part of a growing number of nontraditional
lending activities that have pushed credit in China to levels that are raising
fears among investors and analysts. Jonathan Cornish, the head of North Asia
bank ratings at Fitch Ratings, estimates that total outstanding credit in China
rose to more than 220 percent of gross domestic product last year, up from 130
percent in 2008.

A
typical commodities financing deal works like this: Copper is imported using
letters of credit, warehoused in duty-free zones and pledged as collateral for
cheap bank loans. The loan proceeds are used by the importer to speculate in
higher-yielding, short-term investments. The importer then either sells the
commodity or the investment product after a few months when the original letter
of credit falls due.

The
problem in Qingdao appears to revolve around one such importer. Last Friday,
Qingdao Port International, the biggest port operator in the Chinese city,
announced that the authorities had begun investigating a suspected fraud
related to the aluminum and copper stored in its warehouses. A day earlier, a
report in The 21st Century Business Herald, a respected Chinese-language
newspaper, identified the company under investigation as Qingdao Decheng
Mining.

The
report said Qingdao Decheng was suspected by the authorities of having pledged
the same stocks of the metals — about 100,000 tons of aluminum and 2,000 to
3,000 tons of copper — as collateral for multiple loans, amassing bank debt
exceeding 1 billion renminbi, or $160 million. Phone calls and emails to
Qingdao Decheng’s parent company, Dezheng Resources, went unanswered on
Wednesday.